“If the negative sentiment that was present at the most recent stock market trough continues to be unwound, the VIX could move down to an area between 16.04 and 18.23. The 16.04 level is where the breakout above a trendline occurred in November, which signaled months of higher volatility. The 18.23 level is one-half the VIX’s March closing high…a VIX decline to the 16.00-18.25 area might be considered a place to put on a hedge to a long position, if that makes you more comfortable in this environment.”
- Monday Morning Outlook, March 28, 2022
The S&P 500 Index (SPX -- 4,545.86) managed two closes above its February highs in the 4,600 area before the end-of-quarter and sellers emerged and pushed the index back below those February highs. Meanwhile, the Cboe Market Volatility Index (VIX -- 19.63) traded as low as 18.67, not quite the 18.23 level that marks half its 2022 closing high, but below the 18.89-19.47 levels that mark the index's January and February intraday peaks.
Last week’s VIX trough in this area cannot be a huge surprise, as those anchoring to the 2022 VIX highs may have viewed the subsequent VIX crash as similar to a “50% off sale” that retailers like to use to drive demand. In this case, the VIX’s 50% decline from its recent highs spurred demand for portfolio insurance amid the myriad of headline risks that are front and center everyday.
The long list of worries – continued Covid-related supply chain challenges, the Russia/Ukraine conflict, recent yield curve inversions generating recession/stagflation talk, and Fed uncertainty surrounding a hard or soft landing - may allow stocks to climb a wall of worry in the longer term. This could be especially true after witnessing historical extremes in fear earlier this year, which typically mark historic troughs.
But, as far as the immediate term is concerned, buying portfolio insurance for just half of what it cost just one or two months ago to hedge the obvious risks, and/or lightening up on long positions after the SPX traded 10% above its 2022 closing low at 4,587, also had appeal. This is true especially as the first quarter came to a close last week, typically a time to re-evaluate and reposition portfolios.
Two graphs stuck out to me in the past week. The first suggests heightened risk of higher volatility and lower stock prices in the near future. VIX futures options buyers are again purchasing calls relative to puts at a rate that has historically preceded trouble for equities in the past year.
In the chart immediately below, note how the 10-day buy (to open) call/put volume ratio on VIX futures is approaching the November 2021 levels that preceded a 4% pullback from the early-November high to the early-December low, which was then followed by choppiness into the Christmas holiday.
Fortunately for bulls, if we are on the verge of another pullback like that of early-November into early-December, it won’t be enough to put longer-term investors on alarm.
For example, a 4% pullback from last week’s closing high at 4,631 would push the SPX down to 4,446, above the 4,377 level that I highlighted last week as important to bulls. Refer to last week’s commentary for more details on why this level might have importance when observing price action following strong rallies during the 2000-2003 and 2007-2009 bear market environments.
From purely a technical perspective, the risk-reward for the SPX is neutral in the short-term, with the SPX facing potential technical resistance overhead from its 2021 close, and, above that, the breakdown level from a long-term channel that connected multiple higher lows since late 2020.
Potential support is at the breakout level from a trendline connecting lower highs since November, with additional support from its 320-day moving average. This trendline is currently situated at the top rail of the November-March channel and multiple lows since September.
The second graph that caught my eye is a chart from the weekly survey of newsletter advisors by Investor’s Intelligence. The chart plots the bull percentage less the bear percentage each week. When this number goes below zero, it means there are more bears than bull respondents in the survey.
As you can see on the chart below, the number went below zero in late February, an extreme and a rare occurrence in the long history of this survey. The most recent survey showed the bull minus bear percentage moved back above zero. Since 2016, this has occurred three other times, and each had bullish implications.
The "Since 2016" graph made me curious as to what the historical numbers look like going back to 1972. The first study that Schaeffer's Senior Quantitative Analyst Rocky White shared was disappointing, essentially showing normal market performance.
Digging deeper though, I noticed that three “signals” - one in 1974 and two in 2008 - resulted in 26-week returns of -25% or worse. After reviewing the technical backdrop of the SPX during that woeful performance, I noticed that in all three instances the SPX was below its long-term 24-month, or two-year, moving average. This is a trendline I discussed last week as having importance from a long-term technical perspective.
As such, I asked Rocky for signals when the SPX is trading above its 24-month moving average, as it is at present. The numbers in that study, displayed below, showed significant market outperformance relative to its norm, with the average positive being nearly double the average negative.
In other words, as one might expect, the capitulation of newsletter advisors from bear to bull has stronger bullish implications when the SPX is in a longer-term quantified uptrend, versus a quantified longer-term downtrend. This should give bulls with a six-month outlook the confidence to buy any dips that might emerge in the days or weeks ahead if VIX futures options buyers are correct again.
Todd Salamone is Schaeffer's Senior V.P. of Research
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